Income or Yield Reach in 2010?

In his latest piece, our Real Estate Columnist Michael Douville says retired investors need not "reach" for yield at the peril of capital. He says, instead investors can find reliable and strong income that is within reach in the residential real estate market in 2010 and 2011.

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Income or Yield Reach in 2010?

Income! The Retired, Semi-Retired, Newly-Retired, and Soon-to-be-Retired have a common problem: the bills need to be paid every month!!! Plans and budgets need to be drafted and drawn. A consistent source of monthly income is crucial to successful retirement planning. A growth portfolio of stocks can produce capital gains, but in order to keep the utility company satisfied or plan for a cruise, a portion of the portfolio would have to be liquidated each month. Unfortunately, relying on consistent capital gains has recently been proven to be a losing game. In addition, stock portfolios have been further exacerbated by the volatility of 200 points up on Monday and 220 down on Wednesday.

The volatility and the inability to assess risk have driven many retail investors out of the stock market and into fixed income. The income investor seeking a conservative and consistent revenue stream has created a very crowded trade in US Treasuries. Yields have dropped to insignificant levels… 10-year Treasuries are yielding in the mid 2% range. Often these instruments are bought by investors seeking a safe harbor in turbulent times; at this historic inflection point, the exact opposite may be the result. Should the economy collapse, Treasuries will still perform exceptionally well. If the economy shows any sign of recovering, the bond market will likely suffer severe losses.

The greatest threat to a retired investor is market losses. Many investors are of an age that has no capacity to recover and replenish depleted portfolios. Their life style and perhaps more will suffer if caught in another market bubble burst. The deployment of their financial resources is a very serious issue; consistent income without the depletion of capital is the goal of SWAN Investors (Sleep Well At Night).

Monthly income from Pensions, 401K's, and Social Security have been traditionally supplemented by the interest earnings of the families' liquid nest eggs, which have been accumulated over a life time of savings. No longer can individuals earn any significant amount from bank savings accounts or CDs that are currently earning less than 1%; liquid money markets earn less than 0.5%, causing conservative investors to move into instruments that have longer duration and poorer credit quality. And they do this to earn an extra $500, $1000, or $2000 per month. The consequences may prove disastrous.

"...the perceived safe and conservative investment may prove to be anything but safe and secure."

This "Yield Reach" has caused many closed end mutual funds and ETFs to be priced with Net Asset Value (NAV) premiums of 10%, 15%, and even 20% in some cases, over true asset liquidation prices. Should investors start to exit these assets, the prices would likely fall precipitously, in my view. With yields at historic lows, the path of least resistance may be up. With price declining as yields increase, both the disappearance of the NAV premium and the adverse market reaction could conceivable combine to produce losses of 10-50%. Thus, the perceived safe and conservative investment may prove to be anything but safe and secure.

With the volatility of the equity markets, and the possible bursting of the "Bond Bubble," where can a monthly revenue stream be obtained that, when the economy eventually recovers, will grow the revenue and increase in value? Residential Rental Real Estate today should provide consistent monthly income. I expect its cash flow and the severe price decline recently experienced in the Real Estate market would help to mitigate potential risk.

Not all properties make suitable investment grade rentals. However, in most markets across the US there are properties that have experienced a severe correction and may even be priced below insurance industry replacement value. The risk of further declines is possible, but that risk has been mitigated by the recent depreciation in value, and so we may be closer to the ultimate bottom than near a historic top. Long-term mortgage rates favor today's borrower, and when the recovery is firmly established, the loan costs will still be fixed, but the rental rates will trend higher, increasing the cash flow. As the economy grows, the income stream also grows. The nature of a common fixed rate loan fully amortized over 30 years should now guarantee internal growth, with the ultimate result of a free and clear property that will generate income year after year. No additional market action is necessary. Further, a simple amortizing mortgage with which everyone is familiar, can be customized easily to fully payoff in 10, 15, or 20 years.

No more market volatility to worry about; no more technical analysis needed; no more "Island Tops" and "Head and Shoulders"; no more market openings that gap below the stop order. Instead, a true long-term investment that I expect guarantees huge returns; the tenants will pay the mortgage off and produce free and clear assets with consistent monthly cash flow.

In my home market of Phoenix, Arizona the sun continues to shine, golf is played every day, and rental properties continue to generate cash flow well. Investors remain investors and hire property managers to be the landlord; the property becomes a passive investment vehicle yielding cash flow month after month.

As in any portfolio, diversification is appropriate and only a portion of an investor's total assets should be in Real Estate. As difficult as the Real Estate Market has been across the nation, a suitable property can probably be found close to home; if not, then it can be found in the Sand States of Arizona, California, Florida, and Nevada, which I view ripe. If you believe the largest economy and richest nation in the world will eventually recover, then an enormous opportunity should await.



Editor's Note: Article should interest investors in Bank of America (NYSE: BAC), Freddie Mac (OTC: FMCC.OB), Fannie Mae (OTC: FNMA.OB), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Wells Fargo (NYSE: WFC), Toronto Dominion (NYSE: TD), UltraShort Real Estate ProShares (NYSE: SRS), Ultra Real Estate ProShares (NYSE: URE), ING Clarion Global Real Estate Income Fund (NYSE: IGR), Xinyuan Real Estate Co. (NYSE: XIN), Rydex Real Estate Fund H (Nasdaq: RYHRX), T. Rowe Price Real Estate Fund (Nasdaq: TRREX), Toll Brothers (NYSE: TOL), Hovnanian (NYSE: HOV), D.R. Horton (NYSE: DHI), Beazer Homes (NYSE: BZH), Lennar (NYSE: LEN), K.B. Homes (NYSE: KBH), Pulte Homes (NYSE: PHM), NVR Inc. (NYSE: NVR), Gafisa SA (NYSE: GFA), MDC Holdings (NYSE: MDC), Ryland Group (NYSE: RYL), Meritage Homes (NYSE: MTH), Brookfield Homes (NYSE: BHS), Standard Pacific (NYSE: SPF), M/I Homes (NYSE: MHO), Orleans Homebuilders (AMEX: OHB), Vanguard REIT Index ETF (NYSE: VNQ), PNC Bank (NYSE: PNC), J.P. Morgan Chase (NYSE: JPM), Hooker Furniture (Nasdaq: HOFT), Ethan Allen (NYSE: ETH), Pier 1 Imports (NYSE: PIR), Williams Sonoma (NYSE: WSM), Home Depot (NYSE: HD), Lowes (NYSE: LOW), AMEX: VAZ, AMEX: NKR, AMEX: MZA, AMEX: NXE, AMEX: NFZ, Nasdaq: XNFZX, Nasdaq: FSAZX, Avatar Holdings (Nasdaq: AVTR), Apartment Investment & Management (NYSE: AIV), Equity Residential (NYSE: EQR), Avalonbay Communities (NYSE: AVB), UDR Inc. (NYSE: UDR), Essex Property Trust (NYSE: ESS), Camden Property Trust (NYSE: CPT), Senior Housing Properties (NYSE: SNH), BRE Properties (NYSE: BRE), Home Properties (NYSE: HME), Mid-America Apartment (NYSE: MAA), Equity Lifestyle Properties (NYSE: ELS), American Campus Communities (NYSE: ACC), Colonial Properties (NYSE: CLP), American Capital Agency (Nasdaq: AGNC), Sun Communities (NYSE: SUI), Associated Estates (NYSE: AEC), PennyMac Mortgage (NYSE: PMT), Two Harbors (AMEX: TWO).

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